My most recent books are the Leader's Guide to Radical Management (2010), The Leader's Guide to Storytelling (2nd ed, 2011) and The Secret Language of Leadership (2007). I consult with organizations around the world on leadership, innovation, management and business narrative. At the World Bank, I held many management positions, including director of knowledge management (1996-2000). I am currently a director of the Scrum Alliance, an Amazon Affiliate and a fellow of the Lean Software Society. You can follow me on Twitter at @stevedenning. My website is at www.stevedenning.com.

In first article in this series, I explained how the biggest banks persistently exhibit behavior that the SEC has found to be fraudulent. This asocial behavior continues, despite hefty financial penalties exacted by the SEC. Increasing those financial penalties further, for example, for contempt of court, by itself is unlikely to deter repeat offenses, given the massive amounts of money to which the banks have access and the lack of connection between the penalties and the offenders.

What is the goal of the banks?

According to traditional management, the goal of an organization is to make money for the shareholders. On this basis, the big banks are doing a very poor job. The trajectory of the ten-year share price of the biggest banks is disastrous: declines of minus 92 percent for Citigroup [C], minus 77 percent for Bank of America [BAC], and minus 52 percent for UBS [UBS]. Even the more successful banks are barely managing to maintain the value of their ten-year share price, like Goldman Sachs [GS] and Wells Fargo [WFC], which are only around plus 20 percent.

Harming both the customers and the shareholders

Nor are these banks suffering these setbacks as a result of pursuing the interests of customers. The best measure we have of customer satisfaction is Net Promoter Score as explained in The Ultimate Question 2.0, where we learn that the average national bank with branches has an embarrassing NPS of minus 6 percent. So customers are not happy with the banks either.

If the banks are not doing well for the shareholders or the customers, who are they benefiting? It doesn’t take long to figure out that the banks are being run for the benefit of the executives and traders.

In 2010, shortly after the financial institutions had brought themselves and the global economy to the brink of disaster and had to be bailed out by the government, Bloomberg reported that the eight largest banks set aside compensation of some $130 billion.

Compensation at these levels make the SEC’s penalties of $10 million here or $20 million there almost irrelevant. Even the larger penalties are still relatively small. For instance, in the four years that Lloyd Blankfein has been the CEO of Goldman Sachs, he has earned a total of $138 million. His net worth is reported to be in the order of $450 million. In the very year that Goldman Sachs had to pay out a penalty of $550 million for practices that the SEC has found to be fraudulent, Blankfein got a raise: his bonus increased by $3.6 million. In 2007, when the activities that the SEC found to be fraudulent were occurring, Blankfein made $68.5 million. So how likely is that Blankfein will really care too much about the penalties that Goldman Sachs pays, when several years later the firm admits no liability, promises not to commit that specific fraud ever again, and the deal basically allows the firm and its traders to go on doing they have been doing, i.e. making money for themselves?

Not that Blankfein feels any shame in the situation. On the contrary, he famously told the Sunday Times of London that banking was “God’s work”—a claim that Forbes noted was “every bit as accurate as it is modest.”

In effect, Blankfein is being rewarded for asocial behavior that benefits himself and his colleagues but punishes shareholders and customers alike, as well as ultimately the taxpayers who are called upon to bail out the banks when they periodically get in trouble. Increasing the fines on the firm will have little impact on those responsible for the conduct that the SEC found to be fraudulent, i.e. the executives and traders, while punishing the shareholders even further.

Instead of continuing measures that reinforce bad behavior we need to learn from science what it takes to change pathologically asocial behavior.

The science of changing sociopathological behavior

Science has learned a great deal about what works and what doesn’t. The standard response to such behavior—general rewards and punishments—is usually ineffective in generating sustained behavior change. Instead to get sustained change in behavior, one also needs to change the context in which the behavior is occurring and focus more precisely on exactly the change needed. An interesting article in the Wall Street Journal by Shirley Wang tells us what’s involved in relation to asocial behavior in children, with interesting implications by analogy for banks.

In the case of pathological behavior in children, it has been discovered that the parents need to change their own behavior. Clinicians in the U.S. and the U.K. are starting to adopt approaches based on research clinics at Yale University and King’s College London. The changes focus on three components known as the ABCs:

the Antecedent, i.e. the environment and events that set the stage for the asocial behavior.

the Behavior itself, and how parents can help a child learn new behaviors.

Using this approach even extreme asocial behavior has been curbed. In ABC, the focus of the change is on the parents, rather than the child. In dealing with pathologically asocial children, parents have to learn that they themselves are unwittingly encouraging asocial behavior. According to studies done by the Oregon Social Learning Center, studies show that when the parents change, not only does the long-term behavior of the child tend to improve, but the lives of the parents also improve with gains in income, occupation and education.

Model the desired behavior: It is useless for parents to urge their child to be respectful if the parents are not respectful to each other or the child.

Avoid behavior that rewards asocial behavior: By only paying attention to the child when there is a temper tantrum, the parents may be sending a signal that the way to get attention is to throw a tantrum.

Create expectations of improvement: In one case, parents had spent months begging the child to go to the toilet. They showed him how and explained why, to no avail. When they were coached to set up an expectation of improvement, saying, “You don’t have to go to the toilet today. When you’re bigger you’ll get it,” they were stunned when the very next day, the child started going to the toilet on a regular basis.

Point out good behavior in other children. Pointing to good behavior in others can help, while avoiding rubbing it in, by asking “Why can’t you be like him?” which may set up a counter-reaction.

Identify the specific offending behavior: It is important to be specific about the asocial behaviors to be changed (shouting, screaming, breaking household objects) as well as the appropriate behavior (listening to and consideration others, respect for property).

Role play the desired behavior: Parents are taught to play an imaginary game with their children in which they role-play the tantrum with progressive improvements in behavior. “Let’s pretend you have a tantrum but you don’t throw things.”

Connect the reward with the specific behavior: In dealing with pathologically asocial children, parents have to learn new ways of reinforcing behavior. Instead of general praise like “You’re a good girl!” parents need to be specific about the behavior that they are praising, such as “I asked you to pick up the toy and you did it!”

Reward progressive improvement: When a child screams and breaks household objects when angry, it can be helpful to commend the child when the child stops breaking household objects even if the child still screams. This helps set the child on a course to learn the socially responsive behaviors.

Whether these approaches seem obvious or counter-intuitive, the results are there: the pathological behavior improves.

Applying the research to banks

By analogy, we can learn what is involved in changing the behavior of executives and traders of the big banks who are engaging in behavior that is pathologically selfish and indifferent to the welfare of their customers, their shareholders and society at large. To effect change, the “parents” of the big banks—the legislature, the SEC and the stock market, the regulatory agencies, the business schools—need to make changes in their own behavior in order to make these organizations safe for society.

Like the ineffective parents of pathologically asocial children, the “parents” of the banks are tending to give general rewards for short-term financial performance (stock market gains) and slap-on-the-wrist general punishments when bad behavior is discovered (SEC settlements, courts). Not enough attention is being paid to the Antecedent or context of the banking sector, identifying and encouraging the specific Behavior desired, or the Consequences for specific behavior in terms rewards and punishments.

Here are some of the actions that the “parents” of the banks need to learn:

Antecedents

Clarify the goal of business: The “parents” of the banks—that is, the legislature, the SEC, the stock market and the business schools—need to be clear on what behavior they are trying to encourage. They need to wean themselves of the notion that the goal of business is to make money for shareholders. Instead they should recognize that when banks espouse the goal of making money for shareholders, it rapidly degenerates into a culture of making money for the executives and traders, at the expense of shareholders, customers and society. They need to recognize that we have passed from the Age of Shareholder Capitalism to the Age of the Customer Capitalism, as explained by Roger Martin in his classic article in the Harvard Business Review. The desired behavior is delighting customers, ahead of short-term financial gains.

Recognize that delighting customers makes more money for shareholders: Paradoxically, firms that focus consistently on the goal of delighting their customers make more money than firms that ostensibly focus on making money for shareholders actually do very poorly for shareholders. That’s because the goal of making money per se leads the organizations to pursue behaviors that ultimately lose money for the company, as demonstrated by the very poor returns to shareholders in the banking sector, particularly as compared to firms that like as Apple [AAPL], Amazon [AMZN] and Salesforce [CRM] that do systematically focus on delighting their customers.

Generate reliable information about progress to the true goal: With most banks, investors have information about the money that the bank is making for itself, but little information about how it is serving customers. Yet a standard methodology for measuring customer satisfaction is now available. It’s the Net Promoter Score methodology, developed by Fred Reichheld and described in The Ultimate Question 2.0 . We know for instance that the average customer satisfaction or NPS for US national banks with branches is a deeply embarrassing minus 6 percent. Hundreds of firms are now conducting audited NPS and some firms are now publishing their results, such as Philips [PHG], Schwab [SCHW], Intuit [INTU], Progressive [PGR], and Allianz [AZ]. Reporting such information to shareholders should become compulsory.

Model the desired behavior: So long as the stock market focuses on, and rewards, short-term gains in quarterly earnings, it is not only engaging in predictably irrational behavior: it is reinforcing conduct in the banks that will soon undermine shareholder returns. Instead, the investors need to realize that slavish pursuit of short-term gains tends to result in medium-term losses for shareholders. They need to turn their attention to those aspects of corporate performance that create real value for shareholders, i.e. customer delight.

Behavior

Avoid trying to impose good behavior by regulation: The world of finance is complex, and shifting. Regulations that solve yesterday’s problem unlikely to catch tomorrow’s fraud. Trying to regulate good behavior will result in a mass of paperwork and regulations, and risks being counter-productive.

Clarify and simplify the rules: The Volcker rule aims to impose a ban on proprietary trading by commercial banks, whereby deposits are used to trade on the bank’s own account. The provisions are scheduled to be implemented as a part of Dodd-Frank in 2012. Senator Bob Corker (Republican-Tennessee) is concerned about the efforts to put together regulations that make the distinction clear and even wonders whether we should turn back towards the Glass-Steagall Act, where commercial and investment banking were separated. Thus he said on CNBC’s Squawkbox on October 26, 2011: “The way that the Volcker Rule has come out, we are really getting ready to mess up credit liquidity in this country as it relates to trading credit. It’s going to have an effect on people all across this country. You look at how we try to micromanage every activity these days. You do wonder whether we would be better off taking steps back towards Glass-Steagall.”

Business schools must teach customer capitalism: In 1970, Milton Friedman wrote a famous article for The New York Times Magazine whose title aptly summed up its main point: “The Social Responsibility of Business Is to Increase Its Profits.” Times have changed. We have learned that the unbridled pursuit of short-term profitability by the big banks brought the world to the brink of global financial catastrophe in 2008. If the same behavior continues, another crash or near-crash is inevitable. Business schools must recognize that we now live in an age of customer capitalism where the bottom line of a firm is to delight the customer. Nowhere is this more important than in the case of banks.

Rating agencies must clean up their act: The rating agencies were complicit in condoning and even rewarding some of the riskiest practices in the 2008 meltdown; they received significant compensation for doing so. The SEC has proposed far-reaching rules designed to address perceived conflicts of interest between rating agencies and issuers of structured securities and facilitate “unsolicited” ratings of structured securities by rating agencies not compensated by issuers. Rating agencies have recently begun to downgrade large amounts of mortgage-backed debt. In addition, rating agencies have begun taking action to address perceived or actual conflicts of interest, including additional internal monitoring programs, third party reviews of rating processes, and board updates.

Consequences

Connect rewards and punishment with the desired behavior: Investors should reward firms for gains in NPS, and punish them for low or declining NPS scores.

Point out good behavior in others: Journalists and business schools should point out firms that area excelling in customer delight as shown by audited NPS scores. For instance, in the financial sector, USAA is the leading bank, with an NPS of plus 87 percent.

Reward progressive improvement: Investors should reward firms that make gains in their relative NPS, even if in absolute terms, their NPS is still low. Firms should be recognized for progress in the right direction, even if there is still a long way to go.

Include compulsory training of executives as part of any settlement: Just as in cases of serious traffic offenses, the courts should have power to require executives and traders to take compulsory training in acting more responsibly.

Impose sanctions with teeth: What to do when nothing else works? Enhanced financial sanctions will have little impact because they don’t affect those responsible: the executives and the traders. In addition, the SEC should have the power to remove recalcitrant actors from the game: the SEC should have the power to impose to re-impose the Glass-Steagall Act on any institution that engages in serious repeat offenses. If that doesn’t work, then the ultimate sanction is to reinstate the Glass-Steagall Act on all firms.

Together these actions would amount to a phase change in the context in which banks operate and the way they are run. They require action from the legislature, the SEC, the stock market and the business schools, as well as the banks themselves.

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Correcting Mr. Denning’s blogs is like shooting fish in a barrel. I’ll focus on three points:

(1) The SEC did not “find” that anyone had committed fraud, they alleged that certain actions were fraudulent. We have not yet reached the point where regulatory expansion trumps the presumption of innocence.

(2) In calling for action from the banks’ “parents”, Mr. Denning cites every stakeholder except the ones that matter — the Boards of Directors for the respective companies. Mr. Denning’s theory, expressed in this column and elsewhere, seems to be that evil managers have totally taken over the banks and no longer act in the interest of shareholders. (Elsewhere, Mr. Denning asserts that acting in the interests of shareholders is old-fashioned, but let’s ignore that point for the moment). The implication is that Boards of Directors are stupid. Seems to me that if Mr. Denning really believe this, he should organize financing and launch a takeover bid.

(3) Nowhere in Milton Friedman’s thought does he support the notion of short-term profits at the expense of long-term profits. The liquidity crisis of 2008 wasn’t caused by the pursuit of profits, and shareholder return remains the bottom line of private enterprise. Mr. Denning’s “customer capitalism” is actually socialism. We know how well that worked out.

Thanks for your suggestion. I can see why the grotesque situation that we now see leads to proposals of the kind that you make.

However I have to wonder about their effectiveness. If we look at what has happened in earlier cases where the inquiry has led to a criminal conviction, the process always seems to end up with some lower-level munchkin taking the hit, while the higher-level managers who created the context in which the problem arose get off scot-free. (Skillings at Enron is an exception.) In part, that’s because, as a practical matter of criminal law, it’s difficult to prove intent and pin criminal responsibility on the higher-ups, even though in reality we know that’s what is going on. In any event, even the lower level traders are likely to be thinking that there is very little chance of being caught. So will extreme deterrents really work?

Hence in addition to strengthening the criminal penalties, we also need to focus on remedies that will change the behavior of the higher-ups, i.e. a phase change for the entire culture of these organizations.

While the issues and questions discussed are valid, it is overlooking a critical aspect. “Problems” with Banking cannot resolved within the Banking system. The “Problem” is optimum resource allocation with an economy. Regardless of the constructs for making economy a subset of Banking, the reality is that Banking is a subset of an economy. Issues requiring resolution, in my opinion, need to be framed taking ‘Banking is a subset of an economy’ context. Some of the Banking issues will need to be resolved at the higher order economy-level, and system-of-economies.

Thanks for your valuable comment, with which I agree. If all the big corporations outside the banking sector are pursuing short-term profits and granting lavish compensation to executives for poor performance in terms of creating sustainable growth and value for customers, it is highly unlikely that the financial sector will perform any differently. The financial sector is simply one instance of an economy-wide issue. That’s why an economy-wide phase change is needed.

Behavioral problem (e.g. lavish compensation) is a symptom, not the cause. People are behaving within the constraints or lack of constraints of the financial/economic systems. If enforceable system constraints are clearly defined, unacceptable behaviors will cease.

Finding “system solutions” is more effective than trying to find fix for “behavior problems?”

Steve, were you implying that Amazon, Apple and Salesforce.com are NOT in the business of trying to maximize shareholder return?

That doesn’t sound like a valid implication.

Although, if you were to take this section of your article and do a “global replace” of “banking” with “Congress,” you might see some parallels between the situations and results created by both.

The general electorate holds Congress in VERY low esteem, yet the re-election percentage for members of Congress is astronomically high.

Could you infer from that, that the banking “problems” are similar to or related to the “problems” in Congress, and that the root cause of the problems does not lie with bankers or Congresspeople, but with the Electorate?

Sociopaths/psychopaths shouldn’t be working in the banking system, or any other enterprise that affects the welfare of others. You cannot impose sufficient regulations to control their behavior. It is true of sexual predators and it’s true of financial predators. They lack the ability to feel empathy, they have no internal boundaries with respect to the feelings and rights of others. It’s how their brains are wired. Among the 1 percent of the population characterized as psychopaths, a not insignificant number are thought to occupy the corporate suite. A recent study conducted by New York psychologist Paul Babiak showed that one in 25 business leaders may meet the criteria for classification as psychopaths. (see Guardian article by Steve Morris – September 1, 2011 09.37)

Perhaps customers and shareholders should demand that CEO’s must pass brain scan testing as a condition of employment.